ARE GAS PRICES AND UK INFLATION INTERTWINED?

08.08.2022 The Bank of England has again raised its forecast of peak inflation to 13 percent on the back of higher gas prices. Below we look at the outlook for gas prices and UK inflation more generally.

European and UK gas prices have surged in recent weeks as flows through the Russian pipelines have fallen to around 20 percent of capacity. Russia has blamed the impact of sanctions on its ability to maintain and service the pipelines. It is unclear if and when flows will restart.

More generally, since the end of last year, wholesale gas prices have quadrupled. The extent of the influence of gas prices on UK inflation can be illustrated by the fact that around half of the contribution to estimated peak inflation comes from electricity and gas prices.

It is generally accepted that the dwindling supply of Russian gas is a politically motivated attempt by Putin to damage and divide European countries. In response the Europeans have increased imports of Liquified Natural Gas (LNG) by sea in order to boost the gas in storage in readiness for the winter. Storage is currently at 70 percent and on track to meet the 80 percent target. However, the global LNG market is very tight at present and it is estimated that it will cost ten times what it has in previous years to fill up the storage tanks. This is the key factor behind the rise in gas prices.

European gas prices are now essentially priced for an end to Russian pipeline flows. However, not only does Putin need the revenue to fund his war in Ukraine but he will also need European goodwill to negotiate a peace settlement. Thus, the chances are that gas prices will moderate in the coming months and with them the outlook for inflation in the UK and Europe.

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This post was written by Robin